For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

Every day, I seem to have a discussion with someone regarding strategies for sustaining retirement income in a lower-return world. Investors, particularly retirees, are looking for solutions, and their frustrations are as clear as their request: Can’t someone help? While I can’t fix low interest rates on lower-risk investments (such as high-quality bonds and bond funds), perhaps I can provide some perspective and a solution. As with the old conundrum—is the glass half-full or half-empty?—the answer to the retirement income puzzle is often about perspective.

First things first

The first place to start in a low-return environment would be to minimize your investment costs, including taxes (see: Do sweat the small stuff). Every dollar paid in costs and taxes is a dollar less that you have to spend. Given the anticipation of lower rates going forward, these expenses are likely to be a larger portion of your total returns.

Next, you should review your current income sources and expenses to determine the degree of flexibility in your annual spending needs; this will help you make an informed decision around the spending strategy that’s best for you.

Retirement spending: 3 strategies

I’m not the first person to try to help with this challenging topic, and many spending rules have been suggested to help retirees who want to generate a paycheck from their portfolios. Two of the most popular are the “dollar plus inflation” and the “percentage of portfolio” rules. I’d like to offer what I consider an alternate solution: the “dynamic spending” strategy.

The dollar plus inflation strategy is just what it sounds like. Upon retirement, you select the initial dollar amount you’d like to spend each year and increase that amount annually by inflation. The well-known “4% rule” follows this approach (Bengen 1994[1]). While this strategy allows for rather stable real spending from year to year, it also requires a trade-off: a higher risk of premature portfolio depletion. The chink in the armor for this strategy is that it’s indifferent to the returns of the portfolio, which can be problematic in both bear and bull markets. The result is you could potentially run out of money (or at least have to substantially reduce your spending since you’re not likely to continue spending down to your last $1) in the event portfolio returns are negative, or you could potentially live well below your means and not enjoy retirement to its fullest if portfolio returns are much better than expected.

The percentage of portfolio strategy, on the other hand, may be too sensitive to returns, creating significant income volatility based on market movements. With this strategy, the annual spending amount is a consistent percentage of the portfolio’s value. This approach ensures that the portfolio won’t be depleted, but as the portfolio’s value rises and falls, the income amount will rise and fall as well—sometimes dramatically. Yes, it’s this last part—income falling in response to negative returns—that people often struggle with.

Compared with these two strategies, our dynamic spending strategy is a more flexible approach that moderates the other two strategies’ weaknesses, as summarized in Figure 1.

With dynamic spending, you would calculate each year’s spending in three steps:

Use the percentage of portfolio approach (e.g., 5%) to calculate a spending level based on the portfolio’s value at the prior year-end.

Determine a range of acceptable spending levels based on the prior year’s actual portfolio value. To find the range, increase the prior year’s spending by 5% (the ceiling) and reduce it by –2.5% (the floor).[1]

Finally, compare the results. If this year’s spending amount based on the percentage of portfolio:

Exceeds the ceiling amount, spend the ceiling.

Is less than the floor amount, spend the floor.

As you can see, the dynamic spending strategy is a bit more involved and may require a little more discipline and oversight to follow compared with the other two strategies. Given that, this is certainly one area where working with a financial advisor can make a lot of sense and may even pay for itself.

Worth the extra effort

Our research[2] has shown that using the dynamic spending strategy, a retiree can capture a large part of the sustainability benefits of the percentage of portfolio strategy, but without the strategy’s considerable volatility in annual spending. Ultimately, an investor with endless flexibility would choose the percentage of portfolio approach for its 100% success rate; however, for most retirees this is simply not practical. In that case, dynamic spending can provide many of the benefits of percentage of portfolio without giving up the relatively consistent level of real annual spending.

Perfection not required

In reality, there isn’t a perfect solution, and each strategy requires trade-offs. In a perfect world, we would never need to decide whether a glass is “half full or half empty.” It would always be full, and with our beverage of choice. But neither life nor retirement spending choices require perfection to be rewarding. A dynamic spending strategy can help you negotiate the inevitable trade-offs between spending sustainability and stability, providing you with the financial and emotional resources for a comfortable retirement. Now, where’s that glass?

Colleen Jaconetti

Colleen is a senior retirement strategist in Vanguard Investment Strategy Group. She leads a global team that's responsible for conducting research and providing thought leadership on retirement topics. Colleen specializes in retirement planning, spending, and wealth management strategies. Prior to her current role, Colleen worked as a financial planner in Vanguard's advice department. Colleen earned a B.A. and an M.B.A. from Lehigh University. She is a Certified Financial Planner™ professional and a Certified Public Accountant.

Comments

Kathy B. | March 15, 2017 3:17 pm

I have a question about modifying the 4% rule. My husband and I will be retiring in the next couple of years with a fairly large retirement portfolio (almost all is either in Vanguard or will be). I had planned to use the 4% rule, but in the vast majority of Monte Carlo simulations, I die with more money than I started with. (Yes – I know it can go the other way as well). I am willing to give up the inflation increase for a couple of years at a time when the market heads south. I want to ensure we don’t run out of money but at the same time I don’t want to spend too little unnecessarily. My question is: if in 5-10 years, my portfolio has increased significantly – can I “reset” and do 4% of the increased balance and go from there with the 4% rule?

Richard G. | March 29, 2017 10:10 am

To Kathy B. 3-15-17 3:17 p.m.Mam as a member of Vanguard you can set your program up exactly like you want. You did not share your ages but please be advised that this 4% draw down is a loosely defined % based on you starting your withdrawals at RMD ages.Vanguard can show you several controls that you will enjoy. If your account is large like you say then you may want to consider transferring some of the money over to the Roth arena before you reach RMD’s which would reduce the tax bill when your withdrawals begin at age 701/2.At any time after RMD’s start and you see your account growing you can call up Vanguard and increase the % of your payout.The IRS only puts out the MINIMUM % you must with draw.Another control that you will have is while you must withdraw these minimums after RMD begins there is nothing that says you must spend any of it.You can always transfer the amounts over into the taxable arena and invest in the funds that will keep you in compliance with your overall asset choices.So please do not think that you will be locked in and cannot increase your payout if the need arises.I am sure you know that Vanguard has a RMD service that they provide for their client/owners that will compute your pay out to conform with the IRS.You can sign up as early as 691/2 and get your program set up just like you want.All that will need from you is what account or accounts that you want the money to be taken out of and also how often do you want your checks.Good Luck to You!

Ms. Jaconetti you reply a lot so please comment on my post. Thank You I Love Vangard.
This is My Plan. I am 60 years old, with No Mortgage & No Pension just SS at 66.4 (Full Retirement) which will be about $1,900/month or $22,800/year. I am starting to get tired so I plan on slowing down over the next year or two. Between Working part time and or SS I can live fine on $50,000 a year or a little more if I want to treat myself. If I need a car (every 10-13 years) or a roof, I will just take it out of my Portfolio. Currently my Investments are $1,600,000. and growing at about 100,000 per year invested 75% Stocks, 12.5% Bonds, & 12.5% Cash.. At 61 I could have 1.7 M & at 62 1.8 M. In my 60’s I will move some IRA Money to Roth IRA so that I don’t have a large Tax Bill in my 70’s and beyond. When I die it all goes to Charity. I don’t want to wait to 70 I want to start taking it easier and enjoying it sooner. Any thoughts?

Patrick C. | December 11, 2016 7:08 am

I fund this suggested direction very interesting and make good sense. Here is a question for Colleen or anyone reading the blog or this reply. My wife and I have 2 & 3 years before we start our RMD’s and have been retired for just over two years now. We have not (in these two years) withdrawn anywhere near what the RMD will be, based on current IRA totals. Can you offer suggestion to some solid places to either “store” or invest those additional RMD $ at that point if they are in fact not needed some years? Thanks, Pat C.

Richard G. | December 15, 2016 1:19 pm

To Patrick C. 12-11-16 7:08 a.m.Sir you did not share some very vital financial information that a CFP needs to be able to counsel you in a prudent way.You and your wife’s ages come into play here, the amounts of your respective IRA’s, are you both going to draw S.S., at what ages, are you both going to be receiving employer retirements and at what ages? All of these things come into play before you can determine how to invest these proceeds from your IRA’s.Do you both have good medical coverage from your employer to get you to medicaire ages?I would like to suggest that you call Vanguard and share with them your financial particulars and they will be more than happy to help you set up a program that will help you reach your goals.They are going to counsel a couple differently if you have dual employer retirements and $4,000,000.00 in your IRA’s and full medical coverage from your employer as opposed to a couple retiring on a S.S. check of $1500.00/mon,head over heels in debt and has saved $99,999.00 in their IRA’s.Right now they do not know which of you they are counseling because they do not know where you are starting from.One of the great things about being a Vanguard is they are always ready to help their client/owners.Please give them a call. They know how to make people millionaires.You will find that you will like Admiral shares of both stocks and bonds.Good Luck to you Sir in your retirement!

Josh H. | November 23, 2016 7:25 pm

Donald G. | December 1, 2016 7:29 pm

To Josh H. 11-23-16 7:25 p.m. I applaud your willingness to start saving early.I can almost remember back to when I was in collage.I think Noah was one of my roommates.If I may suggest something young fellow.Vanguard is a big proponent of assembling a financially sound foundation.Having an emergency savings account comes to mind.Having a job also helps when you start your savings program.Vanguard does not want you to even use money in the market if you are going to need it for a minimum of five years. They recommend you do this to keep you from turning right around and raiding your investment account to cover an emergency that came about within this five year window.In other words we are to use only long term money that we can do without for a substantial time.You do not give any financials about your self but I applaud you willingness to save early. Start early (from your first day on your job ) and you will do well!

One thing I did for my kids as they held small income jobs in high school and college is that I funded their Roth IRA for them. Whatever they made I matched and put into their Roth IRA (S&P500 index). I figured this gave them years more of growth even if the amount was not very big. One day my older daughter thanked me for paying for college (they know my story of not being able to afford college) and she asked me how she could repay me. I told her grandchildren and to bury me. She turned to her little sister and said “you bury Dad.”

Donald G. | November 30, 2016 10:05 am

To Jeff R. 11-17-16 1:31 p.m. Sir you do not reveal anything about your self financially.If you are a member of Vanguard then you should know that Vanguard is not a proponent of going “all in” on any one investment.As a member of Vanguard you should never let the short term short falls within your program cause you to do a “knee jerk” reaction and cause you to change your portfolio.If you have set up your program for the long term then you know that you do not buy bonds solely for there return but to also give your investment ship some stability.When your stocks are heading south you are glad that your bonds can anchor your ship and have a anchor that will point toward the north.Vanguard is helping me to become a multi-millionaire by doing exactly what they say.I sure love my admiral shares stocks and bonds.I would like to suggest that you call Vanguard and give them your financial specifics.Once a CFP knows what you have and what you want your money to do for you ,then they can help you manage your “all in fund”. Good Luck to you Sir!

Tom C. | November 6, 2016 4:03 pm

I am 77 and taking RMDs from my IRA which are a bit over $1M. The RMDs are slightly over 4% of the IRA’s value. I try to maintain an asset allocation of 55% low duration bond funds and 45% equity funds across all portfolios (IRAs and non IRA) which approximate $2M and are mostly in Vanguard funds.. My problem is that maintaining this asset allocation is causing the IRA to become “top heavy” in bond funds because most allocation adjustments are made within the IRA for tax purposes. The consequence of this approach is an IRA that is declining in value (after RMDs) while the non-IRA portfolio is becoming more heavily weighted in equity funds. Since the RMDs are a given, I am wondering if my approach should be to maintain the IRA’s value while incurring capital gains taxes by exchanging equity funds for bond funds within the non-IRA portfolio. I have had no problems living off the RMD income plus Social Security

Doug K. | October 25, 2016 5:32 pm

A little off topic but this is funny. Both my annuity companies, Principal and Hartford, are asking me to withdraw all my money ($300,000 combined) so they don’t have to pay the guaranteed 3% annual interest……. Too Bad !!!!!!

Angelo N. | October 24, 2016 7:59 pm

Most people do not retire with 1,000,000 in retirement . So rule are hard to follow depending on your life style . My mother retire with $175000 in a IRA and a paid off townhouse and SSI check. She live on the money for 17 year and left estate worth over $300000 . My point you can’t spend more the you make yearly . And all the rest is just BS . Good luck

Eric T. | October 22, 2016 2:20 pm

All these plans need to be adjusted for age. At age 65 you will probably live another 30 years (per RMD rules) so a 3% inflation adjusted withdrawal would be reasonable. At age 115 you are likely to live only 1.9 years so a 50% rate would be reasonable. As you age travel & entertainment spending will be reduced and long term care will be more urgent. Use IRS Pub 690 Table 3. All this assumes that your return on investments keeps up with inflation in the long term and you are in average health. If you expect to live longer than average; spend less. If you have 6 mo. to live and no dependents, blow it all.

William H. | December 29, 2016 9:26 pm

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.